Foreclosure and business loss

[Questionguy101]

Just want to make sure that I have done it right...

Rental House adjusted cost basis $300,000.

It was foreclosed in 2010. On the Form 1099-A, box 2 'balance of principal outstanding' is $250,000 and box 4 'Fair Market Value of Property' is $100,000.

Since box 5 'Was borrower personally liable for repayment of the debt' is checked 'yes', we use the amount in box 4 'Fair Market Value of Property' as the selling price. So the selling price of the property is $100,000.

Therefore, the taxpayer have a loss of $200,000 that he can claimed in his 2010 tax return. This causes him to have a huge refund.

So actually he gets huge tax benefits because his property was foreclosed. Have I done something wrong in my calculations?

[Questionguy101]

Anyone takes this question...?

[Gary2]

The adjusted basis is $300,000 after depreciation has been subtracted, and only sold for $100K? I knew the real estate market was bad in many places, but didn't realize it was that bad.

In any event, when do you expect to get the 1099-C for the $150K in canceled debt?

[Questionguy101]

The adjusted basis is $300,000 after depreciation has been subtracted, and only sold for $100K? I knew the real estate market was bad in many places, but didn't realize it was that bad.

In any event, when do you expect to get the 1099-C for the $150K in canceled debt?

Yes...it happened in Arizona..I have actually used hypothetical numbers to make it easier to follow my calculations. The taxpayer had actually paid almost $340,000 to buy it in 2006...and the fair market value gave by the lender on the Form 1099-A is only $130,000. Amazing isn't it? Even in Bay Area California, I heard in some area home price has dropped more than 50%.

By the way, why would you think there is a 1099-C coming? It says borrower is still personally liable for the debt in box 5 so the loan has not been forgiven yet.

[Questionguy101]

The adjusted basis is $300,000 after depreciation has been subtracted, and only sold for $100K? I knew the real estate market was bad in many places, but didn't realize it was that bad.

In any event, when do you expect to get the 1099-C for the $150K in canceled debt?

By the way, do you think my calculation of the loss is correct?

[Gary2]

By the way, why would you think there is a 1099-C coming? It says borrower is still personally liable for the debt in box 5 so the loan has not been forgiven yet.

While it's certainly possible that the loan hasn't been forgiven yet, I have seen the 1099-C follow the 1099-A by some weeks, even when the date of cancellation is the same as the date of foreclosure. The fact that the box is checked doesn't mean the loan hasn't been forgiven yet. It only means that the loan gave the lender the right to go after the borrower directly if the foreclosure didn't cover the debt.

Though, come to think of it, if it really resulted in a big refund, there must be other income, and perhaps the lender hasn't given up yet.

But yes, if it's recourse debt, then the gross loss on the sale is $200K. Report it on 4797. Be sure to explain to the client that there are tax concerns over the remaining debt, and that it's not unheard of for the 1099-C to be issued after the general reporting deadline.

[Gary]

Nol

There is a good possibility that your client has an NOL. Look at one of my previous posts last week.

[Questionguy101]

While it's certainly possible that the loan hasn't been forgiven yet, I have seen the 1099-C follow the 1099-A by some weeks, even when the date of cancellation is the same as the date of foreclosure. The fact that the box is checked doesn't mean the loan hasn't been forgiven yet. It only means that the loan gave the lender the right to go after the borrower directly if the foreclosure didn't cover the debt.

Though, come to think of it, if it really resulted in a big refund, there must be other income, and perhaps the lender hasn't given up yet.

But yes, if it's recourse debt, then the gross loss on the sale is $200K. Report it on 4797. Be sure to explain to the client that there are tax concerns over the remaining debt, and that it's not unheard of for the 1099-C to be issued after the general reporting deadline.

That's what i don't understand. So the borrower has to deal with the tax consequence of the cancellation of debt depends on when the lender feels like to issue the 1099-C? It sounds like the lender can decide when the borrower has to pay tax on the cancellation of debt. What about if the lender never issues the 1099-C because they don't see the debt has been canceled yet?

[WhiteOleander]

That's what i don't understand. So the borrower has to deal with the tax consequence of the cancellation of debt depends on when the lender feels like to issue the 1099-C? It sounds like the lender can decide when the borrower has to pay tax on the cancellation of debt. What about if the lender never issues the 1099-C because they don't see the debt has been canceled yet?

The lender has a certain amount of time to pursue collecting the debt. It varies by state. They can decide to sue the t/p or cancel the debt.

The t/p borrowed the money. The lender is the one left holding the bag. The lender is the one out the money.

[jaybird]

The taxpayer should be at the whim of the lender because the Lender is the one who is canceling the debt. So as it stands right now, the taxpayer still owes the balance (debt less foreclosure proceeds) and may have to pay it off down the road. So he may never have to report "cancellation of debt" because it may never be canceled. Take the loss on the 4797, carry forward any NOL, and use that loss down the road if the debt does get canceled.

[snowshine]

Because of statuatory requirements, the 1099-C is almost always at least a year behind the 1099-A here in NC (they need to file with the county in question and then post a series of legal-classified ads in the local paper-of-record). The reason the cancellation is at the, 'whim' of the mortgage holder is that they must jump through the legal hoops to make sure they can deduct the balance as a business bad debt. Each state has their own rules for that.

[AccTaxMan]

The taxpayer should be at the whim of the lender because the Lender is the one who is canceling the debt. So as it stands right now, the taxpayer still owes the balance (debt less foreclosure proceeds) and may have to pay it off down the road. So he may never have to report "cancellation of debt" because it may never be canceled. Take the loss on the 4797, carry forward any NOL, and use that loss down the road if the debt does get canceled.

Is the foreclosure proceeds the same as the fair market value of the property that they put in box 4 of the 1099-A?

[Gary2]

Is the foreclosure proceeds the same as the fair market value of the property that they put in box 4 of the 1099-A?

See the IRS instructions for Form 1099-A. Generally, on a foreclosure, the FMV is the gross foreclosure bid price.

[AccTaxMan]

Because of statuatory requirements, the 1099-C is almost always at least a year behind the 1099-A here in NC (they need to file with the county in question and then post a series of legal-classified ads in the local paper-of-record). The reason the cancellation is at the, 'whim' of the mortgage holder is that they must jump through the legal hoops to make sure they can deduct the balance as a business bad debt. Each state has their own rules for that.

Taxpayer A:

Rental property adjusted cost basis: $250,000
1099A box 2: Loan principal outstanding: $240,000
1099A box 4: Fair Market Value: $100,000
1099A box 5: yes, borrower is still liable for the debt. So box 4 is the FMV.

In his 2010 tax return, he has a deductible loss of $150,000 ($250,000 - $100,000 (box 4))

Taxpayer B:

Exactly same numbers.
Except in 1099A box 5: No, borrower is not liable for the debt. So box 2 is the FMV.

In his 2010 tax return, he has a deductible loss of only $10,000 ($250,000 - $240,000 (box 2))

My question:

Suppose in both situations, the lender decides to cancel the debt in 2013. So both of them will receive the Form 1099-C in 2013 and both of them will have to deal with the same cancellation of debt tax issue at that time.

But taxpayer A got a huge tax advantage than taxpayer B simply because his lender thinks he is still liable for the loan in the year that the property is foreclosed.........am I missing something?

[Maribeth]

Taxpayer A:

Rental property adjusted cost basis: $250,000
1099A box 2: Loan principal outstanding: $240,000
1099A box 4: Fair Market Value: $100,000
1099A box 5: yes, borrower is still liable for the debt. So box 4 is the FMV.

In his 2010 tax return, he has a deductible loss of $150,000 ($250,000 - $100,000 (box 4))

Taxpayer B:

Exactly same numbers.
Except in 1099A box 5: No, borrower is not liable for the debt. So box 2 is the FMV.

In his 2010 tax return, he has a deductible loss of only $10,000 ($250,000 - $240,000 (box 2))

My question:

Suppose in both situations, the lender decides to cancel the debt in 2013. So both of them will receive the Form 1099-C in 2013 and both of them will have to deal with the same cancellation of debt tax issue at that time.

But taxpayer A got a huge tax advantage than taxpayer B simply because his lender thinks he is still liable for the loan in the year that the property is foreclosed.........am I missing something?

If Taxpayer B is not liable for the debt, i.e. the debt is non-recourse, then taxpayer B will not have cancellation of debt. In a non-recourse debt, the lender can only take the property back. Taxpayer B will show a $10000 loss on the property.

Taxpayer A will have the property loss in current year of $150,000. In 2013, taxpayer A will have the cancellation of debt income of $140,000. Net is loss of $10,000.

Maribeth